Summary of International Trade and Foreign Exchange

## Introduction International trade is the exchange of goods and services between countries. It helps countries grow their real GDP, raise standards of living, and access a wider variety of products. Countries trade mainly because of differences in resources, costs, technology and consumer preferences. > **Definition:** International trade is the exchange of goods or services across national borders. ## Why Countries Trade Countries trade to benefit from specialization and to satisfy demand they cannot meet at home. ### Key drivers of trade - Uneven distribution of natural resources and climate - Differences in labour skills and access to capital - Differences in technology and production methods - Changes in population size, income and tastes > **Definition:** Specialization is focusing production on a limited range of goods or skills to increase efficiency. Did you know that international trade has expanded faster than world population over the last 50 years due to lower transport costs and better communications? ## Comparative vs Absolute Advantage Understanding why countries specialise requires two concepts: > **Definition:** Absolute advantage exists when a country can produce a good at a lower cost (or more output) than another country. > **Definition:** Comparative advantage exists when a country can produce a good at a lower opportunity cost than another country. ### How to compare (useful table) | Concept | Meaning | How it affects trade | |---|---:|---| | Absolute advantage | Produce more output or at lower cost | Country may produce that good but trade decisions depend on comparative advantage | | Comparative advantage | Lower opportunity cost | Determines which good a country should specialize in and export | ### Worked example 1: Steel and Coffee Table: units produced per worker-day | Country | Steel | Coffee | |---|---:|---:| | Brazil | $8$ | $40$ | | Japan | $20$ | $10$ | - Opportunity cost for Brazil: to produce $1$ Steel, Brazil gives up $40\div 8 = 5$ Coffee. - Opportunity cost for Japan: to produce $1$ Steel, Japan gives up $10\div 20 = 0.5$ Coffee. - Japan has the lower opportunity cost for Steel, so Japan has a comparative advantage in Steel; Brazil has a comparative advantage in Coffee. ### Worked example 2: Vehicles and Wheat Table: units produced per worker-day | Country | Vehicles | Wheat | |---|---:|---:| | Germany | $10$ | $20$ | | South Africa | $5$ | $15$ | - Germany: $1$ Vehicle costs $20\div 10 = 2$ Wheat. - South Africa: $1$ Vehicle costs $15\div 5 = 3$ Wheat. - Germany has a comparative advantage in Vehicles (lower opportunity cost); South Africa has a comparative advantage in Wheat. Fun fact: Countries often export goods that use their abundant resources intensively, such as oil-exporting countries exporting petroleum-derived products. ## Effects of International Trade - Specialization: Countries focus on industries where they are relatively efficient. - Mass production: Firms produce standardized goods at large scale for domestic and foreign markets. - Efficiency gains: Competition from trade forces producers to adopt better methods and cut costs. - Globalization: Increased interconnectedness of economies through trade, investment and technology. ### Negative impacts - Developing countries may struggle to compete with rich countries that have better capital and technology. - Small local producers can be driven out by large foreign firms and cheap imports. - Cultural homogenization can threaten local traditions and indigenous knowledge. - Environmental damage from large-scale production systems often affects poorer communities disproportionately. ## Terms of Trade (exclude Balance of Payments / Foreign Exchange details) > **Definition:** Terms of Trade (ToT) is the ratio of an index of export prices to an index of import prices; it shows how many units of imports can be purchased per unit of exports. - ToT formula: $$\text{Terms of Trade} = \dfrac{\text{Index of Export Prices